Bermuda is at the forefront of a resurgence of interest in insurance-linked securities. So what are the growing attractions of this risk diversification method?
What is it about 2010 that has caused the resurgence of catastrophe bonds as a form of risk transfer?
According to Reuters, the issue of AXA’s cat bond, Calypso Capital, at the start of November has pushed total 2010 issuance of cat bonds to about $3.147bn. While this is still shy of the various predictions of issuance by market participants – which varied from about $4bn to $6bn – it is still a remarkable achievement.
It follows the extended period of paralysis in the issuance of catastrophe bonds as a result of the collapse of investment bank Lehman Brothers, intricately involved in several early bond issues and the general malaise created by the global financial market dislocation.
The resurgence of interest in insurance linked securities (ILS) is attributable in part to investors seeking diversification in their investment portfolios and acknowledging a lower risk correlation between the performance of these structures and the broader capital markets.
For the first six months of 2010, most issuances were US wind perils, while the third quarter was marked by issuances covering European windstorms.
Another reason for the increased visibility and activity in the ILS space is that these structures are seen as a legitimate alternative risk transfer mechanisms – providing reinsurance and capital-raising alternatives.
I see listing of ILS as vital because listing the structures is what makes them more interesting to investors. Two years ago, the discussion in the market on “do we need to list?” was very different. Following the collapse of Lehman Brothers and its impact of this on the collateral structures of four catastrophe bonds, there is recognition that enhanced disclosure and transparency could accelerate investors’ interest in ILS.
Listing gives investors a greater level of comfort in investing. Exchange listings are a step towards achieving this. Throughout a period of unprecedented stress and volatility in the markets, the regulated stock markets have never failed investors. The world’s stock exchanges remained open and protected liquidity, despite pressure to close. There is a role for stock exchanges to play, to improve transparency and encourage an efficient, liquid market in ILS.
The ILS market is mirroring the broader financial markets, where there is a concerted effort to overhaul how the structured products market is regulated, specifically in the USA.
A move to more ILS being listed on exchanges could generate interest and increase investor demand as it makes the product more mainstream from a capital markets stance. For example, many pension funds have restrictions on investment in non-listed securities. Exchange-listing of catastrophe bonds could be the trigger that attracts more pension money and other institutional investors.
Bermuda could become a one-stop shop for ILS – the sponsors are here, the special purpose insurers (SPIs) are here and the exchange is here. This could accelerate the convergence of the reinsurance and capital markets in Bermuda.
From a jurisdictional perspective, Bermuda has recognised the potential of this market. At the end of 2009 the Bermuda Monetary Authority (BMA), introduced regulation that streamlined the process of incorporation for SPIs, making structure formation more efficient and fast.
It is natural that Bermuda, as the world’s third largest reinsurance market and home to 1,400 insurance companies with total assets of $442bn, is involved in the growing resurgence of this product.
Many Bermuda reinsurance companies have issued cat bonds or set up special purpose vehicles such as sidecars in the past, so there is a committed interest in nurturing the development of this market. The participants in the market understand that they can quickly and easily create a SPI while benefiting from Bermuda’s international reputation and reinsurance market.
All indicators are that 2011 will be another bumper year – our conversations with the capital markets have been hugely positive with more listings in the pipeline. If there is enough traction, we are looking for the market to be more liquid and trading in ILS to really take off. GR
Greg Wojciechowski is president and chief executive of the Bermuda Stock Exchange